IBM Earnings Disappoint Again In Mixed Q2 As Turnaround Remains An Uphill Slog

IBM's ongoing effort to revamp its financial outlook to become a cloud-focused company took another lurching step forward on Monday. Big Blue repeated its months-long rhetoric about a cloud turnaround as it announced a small miss on revenues for Q2 of $20.8 billion, just below analyst expectations of $20.9 billion, alongside non-GAAP earnings per share of $3.84, ahead of the $3.78 consensus.

Shares of IBM, initially up 0.41% on a strong day for the market, dropped as much as $7.50, or more than 4%, as of 4:40 pm ET.

Year over year, IBM's revenue was down 1% on constant currencies, and 13% as reported. Net income was down 15%. The company reiterated full year operating non-GAAP earnings per share of $15.75 to $16.50 with a "modest increase" in free cash flow.

"Our results for the first half of 2015 demonstrate that we continue to transform our business to higher value and return value to our shareholders," CEO Ginni Rometty said in a press release.

IBM's bright spot and continued area of focus was what it calls "strategic imperatives," higher growth revenue areas like cloud subscriptions and analytics. Growth in those two areas came in at more than 30% on constant currencies and more than 20% as reported, including more than 70% cloud growth on constant currencies. Software revenues overall were down 10% for the quarter at $5.8 billion and down 3% adjusted for foreign currencies, while middleware was down 7% and essentially flat when adjusted for currency. [Read more on IBM's software miss and its critical importance here.]

On an earnings call with analysts and press late Monday, IBM chief financial officer Martin Schroeter told investors that IBM continued to feel confident in its "long-term trajectory" to transition to newer businesses. "We are halfway through a transformation here now and you can see it in our results," Schroeter said.

But IBM's strategic imperatives remain just an increasing, but smaller, portion of IBM's overall business. As it nurtures those business units and allocates billions to their growth internally and through acquisition, IBM's become accustomed to reporting difficult revenue quarters after what were once famously stable earnings beats. Now, revenue for IBM continues to decline steadily as its business shifts from on-premise hardware to cloud-based subscriptions. Hardware revenues dropped except for the new z Systems mainframes, which grew 9% and accounted for 24% more delivery power. Revenue for the systems hardware unit was down 32% year to year even after accounting for September's sale of its System x hardware business to
Lenovo for $2.1 billion.

Those deals are splashy and could very well pay off big dividends down the road. For now, IBM's growth areas only account for about one-quarter of its business. Analysts continue to advise investors to essentially hold the course. In the days before Monday's earning report, Cantor Fitzgerald analyst Brian White had written "not to expect fireworks" in the transition year for the company. Bernstein analyst Toni Sacconaghi had written that IBM continued to face near-term difficulties with its ability to grow revenue as services move off-premise to the cloud. "The fall off in IBM's traditional businesses is dwarfing the company's ability to capture new revenue opportunities as the market shifts," Sacconaghi wrote.

Analysts had hoped to see less of a drag on IBM's business from currency pressures, Edward Jones analyst Bill Kreher told Forbes after the company's earnings call late Monday. In Kreher's opinion, IBM's executing well enough on its transition to merit continued patience. "We just don't believe a discount on its share price is warranted," Kreher says. As for whether investors should sit tight until a turning point's finally reached, Kreher argues that IBM's 3% dividends keep buying the company more time. "It allows investors to be paid while they wait."

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